Capitalism: Success, Crisis, and Reform

PLSC 270 - Lecture 7 - Can You Sell a Scheme for Operating on Beating Hearts and Make a Business of It?

Chapter 1. Introduction [00:00:00]

Professor Douglas W. Rae: All right we have here forth flown at a relatively high altitude with the likes of Adam Smith, Carl Marx, Joseph Schumpeter, F.A. Hayek, and today and continuing from here to the mid-term, we’re going to deal with real businesses. And it is our considerable privilege to have with us Sharon Oster, who is a Harvard PhD in Economics, is widely thought to be the wisest owl on the management of non-profit organizations anywhere in the world, and is the Frederick Wolf Professor of Entrepreneurship at the School of Management, and is, in addition to that, a dean of that school. So please help me welcome Sharon Oster.

Chapter 2. Case Discussion: CardioThoracic Systems [00:01:11]

Sharon Oster: Thank you all. In my youth I taught at Yale College and I taught generations of undergrads intermediate micro, so it’s nice to be back amongst you, teaching something a little bit about economics. I hope Doug warned you, but I’m going to treat it like a business school class, which means I’m going to cold call on you, and people in the back should know that I especially like calling on the people in the back because they tend to doze otherwise, so you might want to change your seat. So let’s think about this case a little bit.

So imagine yourself, you’re one of the three entrepreneurs Ferrari, Gold, and Dillon. The world is your oyster in some sense. Here you are, you’ve founded this firm, you’ve got a product that’s this kit that can be used in heart surgery, big market, there’s a million people who need heart disease — who need some kind of heart surgery every year; growing market, we’re all getting fatter, we’re getting older, we’re getting weaker, we’re getting less healthy, you might think that’s a problem for President Obama and the healthcare but it’s an opportunity for our entrepreneurs. This is a — even in the U.S. they could imagine a billion dollar market in this business, not to mention the rest of the world, where people are also overeating and getting less and less healthy over time. Yet when the case opens, they seem like they have some worries on their mind. So if you were one of those individuals, guys in this case, what are you thinking about?

Student: Marketing.

Sharon Oster: Okay, so what do you mean by marketing? What’s the issue?

Student: Well, the issue is you have this product, which could potentially be made into a lot of money and help out consumers, but you have to work through physicians, since they’re the ones who were actually using this device, and for them to use the device, they need training.

Sharon Oster: Okay, so one set of questions we’re going to have are a set of questions about the buyer. There are going to be a lot of questions about the buyer but let’s just get that up there as one set of things we’re worried about. What are you worried about?

Student: I guess I’d be worried about the competitiveness of my product to make sure that it can actually compete on the market.

Sharon Oster: Good. So you know at the moment — let her have it, she’s doing okay — so at the moment I only have one competitor, so what would we call that if we were in economics class?

Student: A duopoly.

Sharon Oster: A duopoly okay. Now one of the things we know about duopolies, if they’re any kind of sensible duopolies they’re probably doing pretty well. This duopolist, my competitor, what’s his price point look like?

Student: Price point?

Sharon Oster: Yeah so he — I’m charging $1,000 for my thing, what’s he charging? Anybody remember the number?

Student: $5,000.

Sharon Oster: $5,000 — they’re good they know the numbers.

Professor Douglas W. Rae: I told you they were good.

Chapter 3. CardioThoracic Systems: Competition [00:04:08]

Sharon Oster: So I’m thinking to myself you’re worried about the competition, but I got one competitor and he’s charging five times my price, that makes me look like I’m pretty good. Is there something else you’re worried about?

Student: Well it’s not just that one competitor, but its other techniques also.

Sharon Oster: Good. Okay, so one thing I’m worried about right now is my existing competitor, but Schumpeter doesn’t tell me that I should only worry about a static competition, does he? What is Schumpeter’s model about what’s happening with competition?

Student: Creative destruction to the other firms that went to market and less successful firms were forced out of the market.

Sharon Oster: So a thing that I have to worry about is not just the extant competitor’s Heartport, but I better think a little bit about who else is coming, so I’m going to be thinking a little bit about what Michael Porter, who you also looked at I guess, is new entry and how do I understand new entry? Then if I think about the flip side of Schumpeter not only am I worried about some new guys coming in and destroying me, but as I come in I’m of course competing against some existing players. I need to think a little bit existing players and the way in which they are attacking this market. One of the things you’re going to observe about almost every new product as it enters the market, even if it thinks of itself as a new product it has existing competitors.

Many of you may have Kindles, if you look at Kindles the Kindle is obviously also worried about what’s happening with the Sony Reader and all the new things that look like a Kindle, but really from the point of Kindle’s — from Kindle’s point of view its real job at the moment is converting all those people who are buying hard covered books. It is thinking a little bit about conversion of consumers from the way in which they are currently used to solving a problem to your new way of solving a problem, so we’re going to have to think here in competition not only about the guys that are doing it our way, but the existing players. And we’re going to have to think about these things in the context of a set of issues involving the customers, how I connect to the customers, how I deliver to whoever these customers are, and we’ll have to think about that, and a set of different products for the needs of our people. I’m going to stay with those two things for awhile and then Doug will help me pull down the slides to get to some other questions in the end, but this is going to take care of us for a little while. Let’s stick with the competition part of it first. Before I came along, kind of how is it that people got their heart problem solved? Guy in the back with the pink shirt in the last row.

Student: Either bypass surgery or the balloon procedure.

Sharon Oster: Good and do you have a vague idea about of these one million patients, about how they divide up?

Student: I don’t know.

Sharon Oster: Anybody else remember about the numbers? They’re not perfect; so the CABG is about 350,000 and the angioplasty —

Professor Douglas W. Rae: There is some hands up; we got to get them to where she can see.

Sharon Oster: Oh, if it’s a number like that you can just yell. You don’t even have to raise your hand. We’re a much more casual group than that in business school. I’ve got two different ways of doing it; let’s stick with you, do you got the mic handy? Good. Tell me a little bit about my organization, CardioThoracics, competing against competitors in each of those two markets.

Student: In the first model of CardioThoracic Systems, it only allowed doctors to do surgery on one or two blood vessels, which would have replaced, I believe, the market for the balloon procedure, angioplasty. Whereas, for the bypass surgery, it was usually, in that case, because they were creating more trauma, they would usually try to address as many vessels as possible.

Sharon Oster: Okay so one of the things about this particular product is in its infancy it could only do one or two vessels at a time, and that limited it really pretty much to this side of the picture, because most of what we were doing — this side of the picture involved, as you indicated, a little more drastic cutting, and typically then more treatment of multiple vessels. Generation 1 sort of focused on this part of the market. Now, as you indicated, the technological trajectory was to more and more vessels, so we’re going to spend a little bit of money if we’re this firm and we’re going to move to not only solving those problems but solving those problems. Does that change come without a cost? As I move from Generation 1 to Generation 2, to Generation 3, I get more and more vessels, do I lose anything?

Student: You have to pay for — you have to invest in the product, you have to train and retrain doctors, you have to market it over and over again.

Sharon Oster: Okay, so one set of questions is as I’m doing anything technological, I’m going to have to invest real cash in this. I’m going to have to think a little bit about that, but is there anything else I lose as I move from one generation to another? Yeah.

Student: Well it’s harder because the whole point is to have a beating heart so it could be longer, so it’s two different [inaudible].

Sharon Oster: Okay, well that’s true. It’s harder to do more vessels because I’ve got more things I’m trying to do as its beating, but there’s something else I’m doing as I move from Generation 1 onward. Yeah.

Student: [inaudible].

Sharon Oster: Great, so if you think about this product in the beginning, it had two kind of technological features. One was it dealt with the bleeding heart — beating heart, not bleeding heart — and the second one it had a smaller cut, so you didn’t want to cut all the way through people, you actually wanted to have a little bitty hole, so small incision, and it turned out that the beating heart eliminated some of the neurological problems, and the small incision made people recover a little bit faster. So they were different elements of the product that we liked. When we moved from the kind of only a couple vessels to many vessels, we’re giving up on some of the functionality associated with the product by cutting up patients a little bit more and that’s another feature that Schumpeter and others have talked about, including Clay Christensen, who talks about disruptive innovation that when you make a product change it is often the case that you don’t just improve, improve, improve, improve. You give up things; there are tradeoffs that you’re making. And the tradeoffs are not just to cost you more money and you get more functionality, but sometimes you actually push along one dimension and you’re drawing back actually in what — in the qualities of another dimension.

In this situation why put the money in and give up the small incision piece just to enable yourself to move into this piece of the market? After all the one or two vessels market is the biggest chunk of the market and it’s pretty darn big, I’m just a little guy, why don’t I manage as I am focusing on that part of the market? Why is it I have to go — why is it I decide to transform myself? Here in the back, the woman in the corner?

Student: Because you have to — [inaudible].

Sharon Oster: You have to say that louder for me or slower, so I got a piece of it but I didn’t get it all, so start again.

Student: You need to think about the preferences of your consumers, the doctor that are going to be adopting your technology, you need a larger incision so they can see the heart that they’re working on. And so it’s not just about moving from a couple vessels to many, it’s about catering to their preferences.

Sharon Oster: Okay, so one of the things I’m going to be thinking about here as I’m thinking about technologically what to do to my product, is that when I change what I can do technologically, I am picking a different set of markets that I’m trying to compete against. And these markets are going to look very different in terms of the kind of buyer issues and the complimentor, and we’ll talk about what I mean by that in a minute, for each of these two parts of the market. I am choosing my competition in some sense by choosing my technology. I’m choosing to go against here a set of — who’s doing these CABG things? These are surgeons, so these are surgeons, they’re cutting people up. Who’s doing the angioplasty? What looks different about that?

Student: Cardiologists.

Sharon Oster: These are cardiologists; they’re being done in a different kind of an office, much less invasive procedure, very different features associated with these two parts of the market. And my ability, given what I am, to compete in each of these two markets is going to vary much, so the technological trajectory is influenced by the economics and the competitive piece of the story. That you are not just imagining yourself, a bunch of scientists in a lab, just trying to make it better, better, better, better. You’ve got a set of managers on top who are saying, “You know what, we need to have an improvement on this dimension, because otherwise we’re never going to be anyplace in this marketplace.” A decision was made, and we’re going to turn to figuring out why this decision was made, that it was going to be important to be in this part of the market and not just this part of the market to get myself some more functionality with multi vessels.

Chapter 4. CardioThoracic Systems: Buyer Issues [00:14:38]

Okay, so to think about why I needed to go that way I want to switch over a little bit to this piece — we’re going to come back to this part in a minute as well. I want to think a little bit about the buyer issues. The woman in the back said if I want to do something about knowing my technology, I’ve got to figure out what does the consumer want. Is that the relevant decision maker in this case? I’ll put that here, I’ve got a patient, and I’ll call that patient the consumer. When people go and they’re trying to have some heart procedure do they just — there’s something the matter with your heart, they just come up to you and say to you, “How do you want me to do that? How do you think — what procedure do you think I should use?” So who else is a decision maker in this situation? Yeah.

Student: The doctor is one of the major decision makers in this process because it’s talking about the whole concept of having the doctor needing to be trained, and using their materials.

Sharon Oster: In fact, there are actually three different doctors you might think play a role in this situation. The one you mentioned is a surgeon.

Student: There’s also the referring doctors.

Sharon Oster: Good, so there’s your basic GP or whatever it is you have, some guy you go, you put on — I’ve got a pain in my chest, he says, “You better do something about that,” and then there is a interventional cardiologist, who does this piece of the business. You — some doctor says, “Go see somebody,” and typically he actually says, “Go see this guy,” and this guy figures out can he help you or can she help you, and if not they send you to a surgeon. You’ve got interveners or decision makers all along the doctor element. Is there anybody else you think that, if I’m the inventors of this little kit, is there anyone else I need to talk too, need to think about? Yeah.

Student: Insurance.

Sharon Oster: Okay, insurance companies. So it turns out, one of the curiosities about healthcare, and it’s the one that’s bedeviling the Obama team now in terms of figuring things out, is we have this breakage of the link between people who make decisions about things and the people who pay for it. In this situation, the patients have some stake in the procedure, the doctors have a lot to say, but the poor insurance companies, and/or the government are actually doing a lot of the paying for it. Needless to say in that kind of arrangement, eventually the insurance company starts having an opinion too and making its opinion felt. If you are in the business of medical devices or pharma, in any way at all, you’re going to be thinking a little bit about how is the insurance company going to reimburse for this kind of a thing? Is there anybody else that has an opinion about this? Yeah.

Student: Hospitals.

Sharon Oster: Hospitals. Why do the hospitals care?

Student: I mean, just from the insurance standpoint, and whether or not they want these technologies to be used at their hospital.

Sharon Oster: So — good. So hospitals actually turn out to have an interesting set of issues about this particular thing. Hospitals, to the extent that they are reimbursed by insurance, and that’s going to be true for most of the patients in this environment, are reimbursed on what’s known as a capitated basis, which means an insurance company says to you, “If you’re treating somebody who has a particular heart problem, I’m going to give you a fixed amount for it.” That’s quite a difference from the way we used to — insurance used to pay, which was, “You treated somebody, let me see what your bills are, I’m going to pay you.” In an attempt to get some kind of efficiency they actually went to a system, sometimes called DRGs, in which they said, “For an average, more or less healthy guy who has this problem, I’m going to pay you X to treat him.” If I’m going to pay — if that’s the way I have my hospital reimbursement happen, how does the hospital feel about my particular device? What do you think?

Student: Not great, probably.

Sharon Oster: Okay, so one thing it doesn’t like is its just costing them money, so it’s kind of just taking it off the top. Might there be anything about it they would like? Yeah, in the back.

Student: The device improves patient recovery time and reduces mortality, because that’s one of the things I wanted to try to quantify.

Sharon Oster: Yeah, and there could be other people who care about the mortality in particular, but the first thing you said was about recovery time. Why might the hospital be especially interested in that? Yeah.

Student: Well because I know for most of the time it — the procedure is capitated for payment, and a lot of times recovery time is also going to fall under that payment, and the longer you recover you’re not going to get any more money for that, so if you have quicker recoveries you’re [inaudible].

Sharon Oster: So it’s actually going to vary for different hospitals depending on the contract that they’re going to get. So for some hospitals I just give you a fee, and that would mean if I get — if this procedure gets you out of your bed and to home faster, that’s a benefit for the hospital because they basically only have to keep you in three days, not seven, I save some money. On the other hand, what does this device do to the amount of time I need to use as an operating surgeon?

Student: [inaudible].

Sharon Oster: Probably increases it. And from the point of view of hospitals, most hospitals are more constrained in operating room time than they are in hospital bed time. Again, it’s going to depend a little bit on the hospital how they feel about this, and a little bit on how much we’ve pushed down in terms of the insurance, but the hospital is definitely going to have some kind of say. Now notice something about these groups, they all have opinions, they all have a role to play in the kind of decision that’s going to affect my ability to compete in these parts of the market. Do they all have the same kinds of preferences? Guy in the orange.

Student: [inaudible].

Sharon Oster: Talk to me a little bit about how each of these players, or a couple of these players, might feel about the idea of introducing this kit that enables people to operate on your heart.

Student: I mean it’s going to have a different response from each one of the buyers. Potentially, doctors can make more money off of it, it’s just if it’s less technologically inclined for example, so I mean their previous systems could have made them a lot more money, whereas patients could actually benefit if this system actually lowered costs, so each one of the buyers is going to have different responses towards costs.

Sharon Oster: Okay that’s a little vague. Let’s sharpen it up. You can sharpen it up for us. It’s not wrong, it’s just a little vague.

Student: Okay so like sharpening things up. In terms of the patient and consumer, I think what he was trying to say, was that with these new technologies it’ll require greater training that the doctor may or may not be able to afford or go through. But it might also benefit a patient because the technology would be less invasive, or something like that. But there’s a higher risk involved because there weren’t as many testing’s that — as were mentioned before, so that could offset the patient preference of going under the knife of something that isn’t that tested.

Sharon Oster: Good. Okay, so a couple of issues here. One is there’s certainly a question about the doctor training, and one of the things that’s going to keep me awake as an entrepreneur is thinking a little bit about the doctor training, which we are going to get to in a couple of minutes. Certainly the doctors are going to be right away at me and saying, “Okay, how am I going to get to learn that kind of thing?” You can already begin to see it’s not going to be the kind of thing I’m going to have a course that I charge for. It is going to be — I’m going to have to figure out some way to incentivize these guys to come to my particular class and learn something about it, and we’ll talk about what that is. The other thing I heard you say was something about risk. Let’s think about the risk issues for the surgeon versus the patient and how they weight those things. Now in theory if we’re doing surgery, what’s the medical benefit of this particular product? The guy in the red in the back.

Student: I think it reduces the mortality rate of patients.

Sharon Oster: Okay so one thing it may do is reduce mortality rate, although it’s a little bit tricky in the beginning, because we don’t know how good the doctors are going to be. The initial real kind of consumer sale piece of this, was less on the mortality and more on what? Yeah.

Student: The recovery rate is whatever they can get out of [inaudible].

Sharon Oster: Okay so some of it is I can reduce your recovery rate. If we think about that, does the doctor care a lot about how fast you get back to work?

Student: No, that’s the — well I mean — yes I guess that’s when it’s your patient.

Sharon Oster: Okay, so one of the things we might think about, the recovery angle is that the patient is going to care more than the doctor. So that’s going to be an element, recovery time, in which we’ve got an asymmetry in terms of how much the people value these things. What’s another element? Yeah.

Student: The trauma.

Sharon Oster: The trauma.

Student: The sudden neurological complications that develop after surgery.

Sharon Oster: Yeah, so another thing about this surgery is you have to be on a heart-lung machine and that actually has neurological problems potentially associated with it. So we’ve got something that’s actually potentially going to reduce some of our neurological problems. It turns out for various studies people have done who study doctors and medical care kinds of things, if you thought about the tradeoff to a patient and asked the question, “How much incremental risk of death would you be willing to face to avoid the kind of very serious neurological damage? The answer to that question is very different for patients then it is to doctors. From the doctors point of view the danger of having someone die on the table is enormous relative to any other problem. From the patients point of view there are times in which they are willing to tradeoff and say, “There are some conditions that I could have that, frankly, I would just as soon take a chance of dying.”

That’s been actually a very complicated set of issues for doctor/patient relationships across a whole range of different operative and surgical procedures. It says to me in this situation, where we are talking about heart recovery kinds of issues, those tradeoffs are going to become potentially very large. When we have a risk of death that’s going to be larger for the doctor, and the risk of damage is going to be conversely more important from the patient’s point of view. Now let’s think a little bit about these different players and look at these two parts of the market. Because we started this by saying that these guys did a whole bunch of technological things to try to move into this part of the market, as opposed to staying in this rather larger part of the market. As we think about these being the deciders among the things, why is it technologically imperative to get out of this market and into this market? Yeah.

Student: Cardiologists would be the ones who refer you to surgery, and if they are the ones who perform the procedure, they then benefit being able to perform the procedure themselves, so they have a quasi-monopoly over the market in some sense.

Sharon Oster: So some people call this the “gatekeeper problem.” It turns out in this particular market I’ve got a gatekeeper problem, which is my big competition, are the ones that are going to basically handle this themselves, and their tendency to then say, “You know, you’ve got two vessels, I could deal with it, but I think you’d be better off going here now that we have a kit,” is going to be much reduced. So I’ve got a problem that my competitor is a gatekeeper for me. There’s another problem also in this — attacking this part of the market. Let’s think about it from the point of view of the patient. How does the patient, who has just one or two vessels damaged, feel about these two procedures? Yeah.

Student: Angioplasty is already quite non-intrusive, so there isn’t a huge benefit gained by trying to — the new, rather untested method.

Sharon Oster: If you think about what this is — I actually did some work for Boston Scientific in this market as an economist and they — even though I was only an economist they actually wanted me to watch one of these procedures for reasons that completely escape me. If you watch one of these things it’s — the patient is awake the whole time. There is — basically what they do is, there’s a little blockage in one of your arteries, they put a thing that looks sort of this, but a little smaller up your leg, they weave it up until it gets to the right part in which there’s a blockage, they have a balloon at the end of it, they have a little machine that blows up the balloon, the balloon just presses against the wall of the artery, all the junk that was clogging it up goes whish and kind of floats away, we hope to wherever nirvana is, and then they take it out and off you go. It’s very non-invasive, that’s very appealing to the consumer, I’ve got a gatekeeper here who’s a cardiologist. What would the insurance company rather have me do? Oh, this is way cheaper. These angioplasty things are way cheaper than anything in the CABG side. So anyone that’s an insurer is going to be thinking, “You’ve only got one or two vessels, go this way rather than trying to do a less problematic version of this.”

From the point of view of solving the needs of these people, I can’t stay in this part of the business. I don’t have enough value add to offer in that part of the business. I have got to go to the only part of the business in which I have potential value add, which is this part of it, and for that it says to me, “Even though I’m going to give up something in functionality I’m going to need to give that up in order to make myself more attractive in that part of the business.” Because from the point of view of everything — pretty much everything these guys care about, this thing is dominated. Now — we’ll come to the little more on the competition in a minute. Let me backtrack slightly from that aggressive comment I just made, because there is one problem, for those of you that read carefully, there is one problem that the angioplasty has that would be improved by me actually trying to do this in a less invasive way. Yeah.

Student: Well one of the problems is that the plaque often returns because the vessel is trying to heal itself, and it can be a bigger problem and you don’t have to do the procedure then.

Sharon Oster: Great. So an issue that we have from the point of view — an issue that this competitor has is something medically, it’s called restenosis, so that I could have this done, but I have to do it many times and then you could think, now what the patient is thinking is, “Do I want to have this with the kit done once, or do I want to have this done every other year, which sounds a little less appealing than it sounded a minute ago when I thought we could just do it once and for all.” Initially you might think, “Well it looks like there is some advantage I could build on in my discussions with patients and doctors, and frankly even insurers and hospitals, that would make me an attractive alternative to this.” But if I was thinking in a Schumpeterian way and going to build my business around that, what else would I want to be thinking about in terms of that strategy? So a strategy that says, “Okay, I’m looking at what these guys are like now and I’m thinking about how I look relative to them, and there is something they don’t do very well, and I’m going to just kind of hammer in on what they don’t do well.” What’s the potential worry that I might have about that? Yeah.

Student: Well, I think it’s just the gatekeeper problem that you were saying. All the people that do that not that well are the people that are going to recommend your patients to the surgeons that you are ultimately selling your product to. So it’s really not going to work out very well.

Sharon Oster: Okay good, so keep the mic. So that tells me if I were going to go that way, what would I need to be doing?

Student: You have to expand so that interventionist cardiologists can use the product, or eliminate the gatekeeper problem in some way, I guess.

Sharon Oster: Okay, so I’ve got to figure out a way to get over the gate. What’s a way to get over the gate?

Student: I have no idea.

Student: Talking to patients so that — you can target the patients so that demand it from their doctor, from their cardiologist.

Sharon Oster: Good. So we could think a little bit about what’s been happening — those of you that watch television, probably none of you anymore — one of the things we’ve seen in the healthcare area is much more direct advertising to patients. Even for things that you would think your doctor — these are things your doctor is going to prescribe for you or make you do in one way or another, there is an attempt in a lot of areas to avoid the gatekeeper by going direct to the patients. How easy is that to do in this market as opposed to a market like allergy relief? Okay, if there’s — there are markets now for Claritin or one of these drugs that is prescription, so the only way you can get it is to go to your doctor, but the line is, “Go to your doctor and ask them to prescribe this drug for you.” Is it going to be easy for me to have on television something that says, “Go to your doctor and tell them you don’t want an angioplasty, you want your CABG done with the beating heart kit?” So why are you all laughing? What’s ridiculous about this?

Student: It’s information asymmetry.

Sharon Oster: Okay, so (a) it’s complicated, information asymmetry is exactly right. You could think, “Okay, I could go to my doctor with that, but what the hell do I know? I mean, really, I’m not going to trust my own view of this even if the television told me so,” but there’s actually another just sort of business issue which is, there, in some sense, aren’t enough people watching TV for whom that message is relevant. Even if I could really focus in on TV and do it I’m going to be — it’s going to be a problem. There are some possibilities maybe on the way. You could imagine a set of web advertisements that when you’re clicking on something that says what do I do about a heart problem? It clicks up to me, “Talk to your doctor about the beating Heartport kit.” So there are some technological things directed at marketing that actually allow us in various markets to get away from gatekeepers and go direct. There’s actually another problem with building a lot on this strategy. As I think about building a strategy to attack an existing player, any of you have game theory? Any of you ever take game theory? Did — any of you economics majors? Okay, good I’m picking on you because you should know this as an econ major. If you’re thinking about positioning yourself against an existing competitor, I’m looking at what this guy is doing now, what else should I be looking at?

Student: How he’s going to react to my reaction.

Sharon Oster: Exactly. I need to be thinking this guy — what is he going to be doing, sitting around, kind of reaping in the profits? He’s going to be thinking about here you came with this new business, and you’re attacking me — by virtue of my restenosis, what am I going to do? Now I want to think a little bit about, if I’m the designer of this thing, is who are these players? Anyone have any sense of who the guys are doing the angioplasty business, producing these balloon catheters and so on? Well they’re big companies, companies like some of you may want to work for some day; Boston Scientific, Medtronic, Johnson & Johnson. What’s true about these big companies? They spend a lot of money on R&D because they make a lot of money. They have broad product lines, they have big cash flows, and they spend a lot on R&D. You, some little pip squeak making Heartport, are going to rack your whole business on the idea that you don’t — you can attack these guys by saying they’re going to have — you’re going back to the hospital a lot, you can be sure they know that’s an issue for their company and they’re throwing a lot of money at it. In fact, what we see in this business is actually we get, very shortly after this position, a new drug eluding stint that allows for less restenosis, that they have spent many, many, many millions of dollars on. I think it is very dangerous to stick with the two vessel thing because you know these guys (a) in the first place, you don’t have the value proposition for consumers, and (b) you’ve got very strong competitors who have a lot of money to throw at a particular problem that they have.

Just a couple more things we want to think about. The training issues; if I’m actually going to make this work in this business I have got what economists would call a complement — with an “e”, not an “i.” I’ve got to somehow — this kit doesn’t do it itself, this kit is used by doctors, surgeons; so I’ve got to figure out a way to train those guys. In the case they talk about some of the ways they try to train these guys. One is they offer them trips to Hawaii. What’s the problem with the trips to Hawaii to learn?

Student: A lot of the doctors are coming there just to look at the actual product not to learn how to use it. It’s like they’ve heard about it, they’re interested just to learn more about it, not actually apply it, and it turned out that I think actually only two people stayed for the surgery on the pig to see what actually happened.

Sharon Oster: Good, and since you’re an econ major we’ll test you a little more on the econ. There’s a problem in economics known as the selection problem, so how does the selection problem play into this? What kind of doctors go to Hawaii?

Student: What kind of doctors go to Hawaii? Doctors that like beaches.

Sharon Oster: Okay, they like beaches, and when they go to Hawaii I’m paying for their transport, but what am I not covering? What’s the magic word — there are only three magic —

Student: Opportunity costs.

Sharon Oster: Oh, thank you, that’s the magic word.

Student: So I guess it would, if we follow that logic, it’s doctors that go to Hawaii instead of being paid heftily by hospitals.

Sharon Oster: You bet, so a strategy that says, “Come to Hawaii,” attracts a bunch of doctors who aren’t doing many surgeries, because they’ve got plenty of time to come to Hawaii. The people that I want to attract are the people that are doing a lot of surgeries because they are an annuity, a word for those of you that are interested in finance. Once I teach them, every year they do more surgeries, every year I don’t have to keep reteaching them every year they do something. Moreover, I want the guys who are in teaching hospitals like Yale because they’re going to teach all the guys behind them, and I want them to be big users, and that’s why most of the training for these kind of things actually happens in the hospital. It doesn’t happen in Hawaii. Hawaii sounds great to somebody who doesn’t know anything about doctors. What you want to do is you want to go where they are, train them where they are, where there’s low opportunity cost of learning as a way to capturing.

Still it’s going to be a tricky piece to try to do it.

Chapter 5. Case Summary: CardioThoracic Systems [00:40:06]

We have a situation in which it looks like a good idea; we’ve got big hurdles to go over in terms of actually having a value add that’s meaningful. Suppose I could, suppose I did have something that I convinced — I got enough dotors to know how to do it, I got enough stories to consumers and others that I got around intervention cardiologists — there’s a lot of ifs about this — and I’m getting some penetration of this thing. Now what am I worried about? Yeah.

Student: Is insurance going to cover it.

Sharon Oster: Okay I could worry about — is insurance going to cover it? But suppose I got that, I’ve managed to convince those insurance companies that this is going to get people out of the hospital faster; this is going to be a good deal. Here I am just starting to make money. What do we know when you’re just starting to make money? What happens to you? What kind of a science is economics? The dismal science; why is it the dismal science? Because the minute you start making money what happens?

Student: People enter the market.

Sharon Oster: People enter the market. That’s the glory of why prices come down. In this situation what kind of a product do we have? We have a little platform for a beating heart. When we convince the doctors to adapt it, we want it to have something that was going to look pretty generic, because I wanted to give doctors some sense of, “You can learn how to make this, and I’m not going to hold you up eventually.” The easier it is to copy, however, the more problem I have from new entry. Even if I can crack this problem by attracting the right buyers, solving the complimentary problem, changing myself technologically to hit the only part of the market in which I have a chance to compete, I’m going to have a problem that I’m going to have the risk of new guys coming in. The more attractive I make this from a generic point of view in the beginning of my market, the more problem I’m going to have protecting it in a later part of my market. That, in some sense, is really the Schumpeterian story that says to me the nature of an innovation is coming in against existing players with something you hope will be a better idea. Then worrying in the end about other people who are going to imitate you, until finally there are enough of them until another newcomer comes in with another disruptive innovation that looks better than what you had before. I have to actually go teach my MBAs and so your last five minutes Mr. Rae is going to complete for you.

Professor Douglas W. Rae: As you can see she’s done that before. Now the question the syllabus poses for you is concerned with social learning, with whether the market and companies like this one are instruments by which society learns through both success and failure. Does anybody see a learning component to this? Let’s get a mic for somebody. Let’s go to purple shirt right here. What’s the learning process here?

Student: Do you mean the learning process for the players in this particular case?

Professor Douglas W. Rae: Well I mean something more abstract and bigger. Is society smarter in any important way toward the end of this story than it was at the beginning?

Student: I suppose it — I suppose it depends on whether the new product ends up being adapted, because if it — I mean if it ends up being sort of accepted, because then in which case we’ve had a technological innovation that will maybe save some lives, reduce some recovery time, but if the product never enters the market — I mean, I guess if there’s this pressure to innovate, even if it doesn’t enter the market, maybe the angioplasty guys will be out there trying to compete even though it’s not really a major competitor.

Professor Douglas W. Rae: Okay so in actual fact there’s a learning story with a yes answer and a learning story with a no answer. The learning story with the yes answer is very obvious. The learning answer with the failure story is partly that we know one bad idea so we don’t have to repeat it. In addition, it’s part of a larger incentivation process which compels everyone to be thinking about the next step beyond what they already know how to do. In the case for Monday, which is its URL is posted on class as V2; we have the Polaroid Land camera, invented by Edwin Land. It is a less bloody story that is a little like the one we just did. The difference is that it is closer to the mass consumer and is in that way a more typical Schumpeter story about how innovation in consumer products disturbs an old equilibrium in conventional photography and then becomes a defender against a new disruptive technology with the emergence of digitization. We’ll see you on Monday.

[end of transcript]

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